Refinancing can work to the homeowner’s advantage when the circumstances are right. A change in one’s financial standing or in the market environment, e.g. fluctuations in bank interest rates and property prices, often opens opportunities to take advantage of refinancing, with the aim to minimise debt and maximise equity. Moreover, whether suffering from financial difficulties or enjoying a high credit rating, it is always good practice to be aware of the available refinancing options.
Stuart Roe, Head of Mortgage Services, In-house Mortgage Services, says, “Property refinancing is when another or the same bank either buys out the existing mortgage or restructures the existing product over a different term or with a different set of rates and conditions. There are different industry jargons for refinancing such as ‘equity release’, ‘further advance’ and ‘buyout’.”
Siddarth Razdan of I Capital Management Services, a corporate finance advisor, adds, “Refinancing is sought primarily as a tool to partly unlock the cash blocked in the asset without selling the asset, and taking advantage of scenarios such as lower interest rates or extending the tenure of the loan to suit cash flows.”
A reduction in the interest rate attracts many homebuyers to seriously consider refinancing. Danielle Suchley, Head of Operations, Fund Advisers, says, “Interest rates have decreased significantly over the past five years in the UAE. Even a 1 per cent change in mortgage interest rates represents a huge saving over a long-term mortgage. For example, a 1 per cent reduction on a mortgage worth Dh3 million over 20 years would yield a saving of Dh388,000. That said, it is no easy task to exit many of the mortgage arrangements currently available in the local market, as many providers impose high penalties and fees for allowing the homeowner to exit the arrangement.”
Rajiv Shah, Head of Wealth Management, Earnest Advisors, says mortgage rates specific to the UAE peaked in 2009 at 9.5 per cent and have since hit as low as 3 per cent at the end of last year. “If you were smart enough to get on the bandwagon at 3-3.5 per cent and fixed it for a number of years, then you’ve done pretty well. Today, mortgage rates are around 4.49- 7.5 per cent with each lender having its own set of strict criteria,” says Shah. “The mortgage industry here is not nearly as well defined as it is in developed markets such as the UK and US. But at the same time, you do have exposure to a good range of international banks [lenders]. Mortgage brokers here are very few, but it can only get better.”
Reason to refinance
Clearly defining the purpose of refinancing one’s property will help determine the changes suited to one’s needs. Roe says refinancing can be used for various purposes, such as getting a lower interest rate, acquiring a better product, raising money to consolidate other finances or building an investment portfolio by leveraging an existing property to get a better rate and use the capital as a down payment for a second property. “Reducing the monthly instalments on all of your existing finance is generally considered a way of better managing finances,” adds Roe.
Understanding how refinancing works is essential to secure the right deal, says Shah says. “You can reduce costs and eliminate the risk of future hikes in the shorter term through refinancing. Small differences in interest rate make a big difference. Whenever interest rates are at lower levels and potentially seen to rise over the next year, the appeal of fixing the rate or refinancing your mortgage with another lender grows,” adds Shah.
Swati Pant, RakBank Head of Mortgages, further explains, “Mortgage customers choose to refinance their property when they recognise a need for liquid cash, whether for personal or business purposes. Other main reasons to refinance include an increase in property prices and the availability of equity at lower interest rates and charges [compared to unsecured loans]. Therefore, refinancing is attractive to a mortgage customer when the property value appreciates, when interest rates are low and when loan-to-value [LTV] ratios are high based on current market prices.”
While refinancing your loan can be an excellent option, any home-loan transaction comes with expenses such as lender’s fees and legal fees, warns Shah. “The lure of lower interest rates and monthly payments may look good, but you have to understand the risks. Your home may be your most valuable financial asset, so you must be careful in choosing a lender or broker and specific mortgage terms to refinance it, as the right loan and the right people helping you could save a lot of money,” he adds.
Warren Philliskirk, Associate Director at Mortgage International, says clients look to get a better mortgage deal, but sometimes they become reluctant to move as there are costs involved. Philliskirk explains, “What you have to fully consider is the total savings over the whole term of the loan, not just the initial savings. The long-term savings of reducing your interest or profit rate, coupled with ensuring you do not get into a product that traps you, will save you a fortune over the long term.”
Philliskirk says the following fees apply when switching to a new lender to get a better deal:
- The penalty would range from 0-5 per cent of the existing loan amount.
- The new lender’s arrangement fee is 0-1 per cent of the new loan amount.
- The new lender’s valuation fee can reach up to Dh3,000. In some cases it is waived.
- The Dubai Land Department mortgage registration fee is 0.25 per cent of the loan amount.
- If a mortgage advisor is used, the fees for such services could reach Dh5,000, but don’t pay more.
When releasing funds from an existing unencumbered property, the aforementioned fees also apply, except for the penalty, which is not applicable in this case.
Razdan says all banks and financial institutions have roughly the same terms when offering mortgage loans, which can reach up to 30 years. Normally, long-term interest rates tend to be less volatile than short-term interest rates. He adds, “Banks and financial institutions typically finance up to a certain percentage of the current market value of the property, primarily depending on the credit worthiness of the borrower, whether the borrower is an expat or a UAE national and the internal assessment of the property. They reserve the right to ask for additional margin or collateral in case of a steep fall in property prices.”
Moreover, there are different types of products offered by banks through “equity release”, “buyout” or “new purchases”. Roe says, “Some banks may favour taking existing well-conducted mortgages from other banks as those already demonstrate a good-paying client, thus the risk is lower. Some banks look to get a bigger foothold on the growing market and therefore increasing the presence through ‘new build developments’ or ‘specific developments’ or areas. Some banks may not favour offering a client equity release on an unencumbered property because they do not know what the extra capital will be used for and therefore see it as high risk.”
Prepare for a good deal
Most banks regularly come out with incentives and special limited-time offers. This is usually the optimal time to look at refinancing, advises Shah. A borrower can apply for a mortgage loan from any bank, not just the bank where the salary or savings are deposited, but some do require a salary transfer, adds Shah.
“A variety of factors can keep you from qualifying for a mortgage. The big ones include a low credit score, insufficient income for the size of the loan you want, insufficient down payment and excessive debt. All of these factors are within your control,” Shah explains.
He offers the following advice for a borrower to overcome these obstacles:
- Repair or increase your credit score, which represents the likelihood that you will make your mortgage payments in full and on time every month. To a lender, this is very important.
- Look for a higher-paying job. Switching companies can also be a good way to get a significant boost in income.
- Save like there’s no tomorrow. The larger the down payment the smaller the mortgage amount that you’ll need, and the more likely you will qualify for the loan.
- Reduce debt. If the total monthly debt payment is too high for the borrower to afford the monthly mortgage payment, for the lender that constitutes excessive debt.
Roe adds, “The property must be maintained at all times to ensure the correct valuation price. Your health is also a factor in getting finance as it is mandatory for all applicants to have life insurance. If a client fails to show a good state of health, this can sometimes affect the cost of the insurance and may mean that the refinance is no longer an affordable option. Lastly, make sure you have a good independent mortgage consultant that can negotiate on your behalf and source the best deal for your individual needs.”
Moreover, rates can fluctuate a lot in terms of the requirement for refinance, while the tenure and the borrower’s age are also factors, says Roe. “If the client is having a rate of 8.5 per cent and is able to secure a new deal at 4.5 per cent, then it would make perfect sense to consider refinancing. Rates are always changing from month to month and it would be wise to conduct a financial health check to see what products are available at that time,” he adds.
Benefits of refinancing
Refinancing your mortgage can be a great decision, given it is done in the right circumstances, says Shah. “Reducing your interest rate not only helps you save money via lower monthly payments, but it also increases the rate at which you build equity in your home. You will pay the lender’s fees, but ultimately you save money on future payments due to a lower interest rate with the new lender. Refinancing is a valuable tool in getting your debt under control,” adds Shah.
Roe further explains, “Many clients still have mortgages from five or six years ago where the lenders may not have adjusted their rates in line with current products. Some clients that I have done refinance packages for have had a lot of benefit whereby their current rates may be as high as 8.5 per cent and we have agreed on new rates as low as 3.95 per cent. In cases where a client has a lot of equity, we have also helped in getting refinance as well as a new finance, therefore creating 100 per cent financing for the second property at no cost to the client, as all costs are absorbed into the capital raised from the existing property.”
When not to refinance
If you’re still in the first few years of your mortgage, refinancing isn’t a big deal, but if you’re further along in your mortgage, you should run a calculation to see if the lower interest rate really justifies the rewind, says Shah.
He explains, “When you start a new mortgage, the majority of your payment applies towards the interest and only a tiny sliver will go towards your principal. At the end of your first year of mortgage payments, you will see that you’ve barely made a dent in your principal balance. The further along you progress, the more your payments will apply to your principal. By your 20th, 25th or 30th year, nearly all of your payments will be applied towards your principal.”
So how does it apply to refinancing? “When you refinance a mortgage, you re-set the clock back to year one where majority of your payments will apply toward interest, not principal.”
Philliskirk says any financial decision of this size needs to be thoroughly thought out and calculated. “For instance, there is no point in moving banks and incurring 5 per cent in penalties, unless you’re going to hold the property for a reasonable amount of time and recoup the benefits financially. So if you’re planning to sell in a year or two [when there are generally no fees in doing so] then suffering the high rate rather than creating costs might be the most economical thing to do,” advises Philliskirk.